*How to profit from US government spending

*The next big shock of 2009 will come from China

From David Stevenson, London

Dear MoneyMorning reader,

You know things are bad when you read constant reports comparing today’s crisis with the Great Depression - and you don’t even look twice.

We all know by now that a good chunk of the world’s banks are as good as bust. And like it or not, the governments of the world have decided to step in and ‘save’ them, and the rest of us, with “stimulus” packages.

It’s hard enough to know what to expect at the best of times. But with governments launching new schemes every other day, and more nasty surprises potentially on the horizon, it’s tougher than ever.

So what can investors do? Simple - just follow the money...
 

The next big economic shock - a slump in China

The Capital Economics team is the latest to produce an analysis of the period between 1929 and 1933. “The main culprit was the bursting of bubbles in the equity and commodity markets, accompanied by falling house prices”. Sounds familiar – not to mention a little obvious.

While Capital isn’t convinced we’re set for a repeat Great Depression performance now, it says the “risk is significant… the similarities of the problems in the banking sector are spooky”.

And even as investors are starting to reconcile themselves to the idea that the banking sector is a busted flush, they’re about to get another big shock – this time from the Far East.

Remember all that de-coupling nonsense we heard a few months ago, about how Asia would be able to withstand a US recession? It’s history.

Last year the Chinese economy grew by 13% and was the biggest contributor to world growth. But by the fourth quarter of 2008, the annual growth rate had dropped to 6.8%, the slowest in seven years. And this year, China’s going to suffer big-time, just like the rest of the world.

Ryan Atkinson at Balestra Capital highlights three sharp slowdown signs: a drop in power output at the end of last year for the first time since 2002; the biggest slide in exports last month for almost 10 years; and the OECD’s index of Chinese economic indicators tumbling to their lowest level since records began in 1983. It all adds up, he says to a mere 2% growth in 2009, compared with Bloomberg’s consensus survey expectation of nearly 8%.

But when we’ve got so much to worry about already, can this really make things any worse? Sadly, yes, says Atkinson. Weaker than expected Chinese growth will give the financial world yet another nasty shock, hitting share prices in the process.

Societe Generale’s Albert Edwards, who’s been right on the money during the financial horror story so far, agrees. He said last week that the “implosion” of growth in China could be “the real surprise” in 2009, which in turn could prove to be “an even bigger shock for investors than 2008”.

Beware cheap looking stocks

So if you still have money in the markets, what’s the bottom line? Strategists have been queuing up to tell us there’s a rally on the way. But as Pimco’s Mohamed El-Erian says, most pundits “simply don't get it! How else do you account for so much eagerness to call a market bottom even though the global system continues to transform itself in front of their eyes, and in an unpredictable and previously unthinkable manner?”

It’s tempting to look for a rapid return to “normality” and “business as usual”. And there are stacks of apparently cheap assets out there. But most will get cheaper still.

Global economic activity will keep falling off a cliff for the foreseeable future, regardless of what governments do. Many investors have been so badly burnt they’ll be avoiding the markets for a long while. And a barrow load of new regulation is about to be shovelled onto financial markets.

Further, to try to make up for all the failures so far, governments will be getting more and more involved in those markets in unusual ways. That will have both intended and also unintended results.

The old investment rules are out

So the old rules are out. Don’t buy anything simply because it looks good on a historic valuation. Don’t buy in the hope there’s about to be a bounce back in the economy. And be wary of government bonds, lots more of which will need to be flogged off by politicians, which will ultimately lead to inflation and in the UK’s case, the pound falling further.

But where you see a sector receiving sustainable government support – as opposed to attempts to fill in near-bottomless pits, as with the banks - that’s the place to be. In other words, look for the places where those politicians will be sloshing your cash around.

As El-Erian says, “in this new age of state intervention, investors must struggle to survive. This is not familiar, nor is it desirable”. But like it or not, it’s the new real world.

We’re still waiting for a proper overview of the new President’s infrastructure plans. But in the meantime, one place where Pimco’s Bill Gross reckons government money will be flowing is to local and state governments (‘municipals’) in the US, many of which are facing near-bankruptcy. These are unlikely to be allowed to go under – so buying their bonds now could be a good bet.

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Turning to the wider markets...

The JSE all share index gained 2.94% yesterday. The gold mining index climbed a massive 9.39%.

Resources closed up 5.55%. Banks shed 0.03% and financials increased 0.79%. Industrials rose 1.38% and the platinum mining index added 4.44%.

London’s FTSE100 closed up 3.86%. The Dow Jones lost gained 0.48% and the Nasdaq increased 0.82%.

Tokyo’s Nikkei surged up 4.77%. Hong Kong’s Hang Seng was closed for a public holiday.

Brent crude is currently trading at $47.45 per barrel.

Spot gold’s trading at $904.03 and platinum was last quoted at $956.50.

Until tomorrow....

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